U.K. Banks Seen Sacrificing Lending to Meet BOE Demand

While trimming or delaying dividends, selling assets, reducing pay or raising equity would also bolster capital, banks such as government-owned Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc may be tempted to shrink lending, said Paul Mumford, who helps manage about 350 million pounds ($569 million) including Barclays Plc, RBS and Lloyds shares at Cavendish Asset Management Ltd. in London. Photographer: Chris Ratcliffe/Bloomberg

Dec. 21 (Bloomberg) -- U.K. banks, under pressure from the
Bank of England to increase capital, may do exactly what the
central bank doesn’t want them to do: Cut lending.

While trimming or delaying dividends, selling assets,
reducing pay or raising equity would also bolster capital, banks
such as government-owned Royal Bank of Scotland Group Plc and
Lloyds Banking Group Plc may be tempted to shrink lending, said
Paul Mumford, who helps manage about 350 million pounds ($569
million) including Barclays Plc, RBS and Lloyds shares at
Cavendish Asset Management Ltd. in London.

“I’m not sure how they will get the capital, but one of
the ways is lending less money,” Mumford said. “You can’t
encourage banks to lend more and tighten up on the other end of
the scale.”

Britain’s four-biggest banks may need as much as 60 billion
pounds in extra capital to meet future loan losses, compensate
customers and pay regulatory fines, according to the Bank of
England’s Financial Stability Report last month. Central bank
Governor Mervyn King is pressing banks to raise capital levels
without reducing lending to support an economy struggling to
avoid a triple-dip recession.

“If you tell banks that they need to raise capital, they
may try to preserve that capital position by not lending,”
Vivek Raja, an analyst at Oriel Securities Ltd. in London. The
Bank of England is “at odds” with this view because it said
banks need clean balance sheets before they can provide new
loans, Raja said.

Pared Lending

Lloyds, the U.K.’s largest lender to families and small
businesses, pared back lending in the third quarter by 2.77
billion pounds, according to the Bank of England’s Funding for
Lending Scheme data.

The program, which started on Aug. 1, allows banks to
borrow U.K. treasury bills to help lower the cost of loans for
small businesses and home-buyers. The plan was designed to boost
credit by at least 80 billion pounds and revive growth, it said
at the time.

While Barclays helped British banks to increase lending by
496 million pounds in the three months to Sept. 30, Santander
U.K. Plc and RBS cut back.

Reducing lending “doesn’t increase the pounds amount of
capital, it increases the capital ratio,” said Ian Gordon, a
London-based analyst at Investec Plc. “That’s precisely what
the Bank of England has allegedly said isn’t acceptable, but
it’s what I expect to be delivered.”

Triple-Dip

Chancellor of the Exchequer George Osborne is urging banks
to lend more to stimulate growth after Britain’s economy emerged
from recession in the third quarter. The U.K. risks entering its
first triple-dip recession since records began 60 years ago, a
Bloomberg News survey of economists said last month.

“Credit is the lifeblood of the economy,” said Vicky
Redwood, chief U.K. economist at Capital Economics Ltd. in
London. “Firms have retained profit to spend and households
have their income, but many spending and investment decisions
hinge on being able to borrow from banks.”

The central bank in November said it had asked the U.K.’s
Financial Services Authority to review whether banks have
adequate capital. Capital ratios may be overstated by as much as
35 billion pounds, it said. A further 10 billion pounds may be
needed to cover the repayment of customers wrongly sold products
and an additional 15 billion pounds for extra provisions on bad
loans.

‘Strengthen Resilience’

The Bank of England’s “recommendation is designed to
strengthen resilience in the banking sector and, by tackling
balance sheet problems, increase its ability to support new
lending to households and businesses,” said a spokesman for the
central bank in a statement. “There are a number of possible
actions banks can take to strengthen resilience in ways that do
not hinder lending to the real economy.”

The push to enhance the financial strength of banks comes
as lenders prepare for tougher capital rules under Basel III.
U.K. lawmakers in the Parliamentary Commission on Banking
Standards today also pressed for the government to have greater
powers to break up banks should they fail to comply with
proposals to build firebreaks around their consumer operations.

Shrinking the balance sheet, “is precisely what is
continuing to occur,” said Investec’s Gordon. “You only need
to look at the funding for lending figures.”

‘Difficult’ Assets

Lloyds and RBS have the most capital to raise because of
their higher ownership of “difficult” assets such as
commercial real estate in Ireland, Morgan Stanley analysts
including Chris Manners wrote in a Dec. 17 note to investors.

HSBC declined to comment beyond its Nov. 5 earnings
statement, which said it generated $2.8 billion of capital in
the quarter. Lloyds declined to comment beyond its Nov. 1
results, which said “we have a strong capital position and are
confident that we will meet future regulatory capital
requirements.”

A spokesman for Barclays declined to comment beyond Finance
Director Chris Lucas’s comments on Oct. 31 when he said that the
bank’s “capital and liquidity remains strong.”

A spokeswoman for RBS declined to comment.

Uncertain Environment

“The U.K.’s banks are well capitalized and positioned for
the transition to Basel III,” the British Bankers’ Association
said in a statement. “But, as the Bank of England’s Financial
Stability Review noted, they are operating in a challenging and
uncertain environment.”

One option to raise capital could be to follow the example
of Barclays, which last month issued $3 billion of 7.625 percent
subordinated 10-year notes, which will be written down to zero
if the U.K.’s second-largest lender has losses that reduce its
core Tier 1 equity ratio to 7 percent or lower.

The Bank of England Financial Stability Report in November
suggested banks could issue such contingent capital instruments.

“The fact Mervyn King and the financial stability board
have thrown their weight behind it suggests Lloyds and RBS will
issue some Co-Cos,” said Cormac Leech, an analyst at Liberum
Capital in London. “The nice thing about Co-Cos is they would
mean treasury wouldn’t have to stump up more cash and it would
avoid equity dilution” for the U.K.’s part-nationalized
lenders, he said.

Sell Stake?

Banks may also try to sell assets to bolster capital.
Lloyds could sell half its insurance business, including
Clerical Medical and Scottish Widows, Leech said. The bank plans
to raise about 1 billion pounds by selling its stake in U.K.
wealth manager St. James’s Place Plc, the Sunday Times reported
on Nov. 4.

U.K. Financial Investments Ltd., the steward of the
government’s 81 percent stake in RBS in October said it had
written to the bank to suggest the lender sell its U.S. unit,
Citizens Financial Group Inc., to increase shareholder returns.
RBS Chief Executive Officer Stephen Hester in November said it’s
a core part of the bank.

Cut Price

Banks may have to cut the price of assets to achieve sales.
RBS will probably have to accept a lower offer for 316 branches
it has to sell after Santander abandoned a 1.7 billion-pound
offer for them, a person with knowledge of the matter said last
month.

Barclays and RBS may need the most capital because of their
potential bill for litigation related to the manipulation of the
London interbank offered rate, Leech said.

Barclays was fined 290 million pounds by regulators in June
for manipulating Libor, the benchmark for more than $300
trillion of contracts from mortgages to interest-rate swaps.

U.K. lenders may also have to add to a total of about 11
billion pounds set aside already to compensate clients who were
forced to buy, or didn’t know they had bought insurance to cover
their repayments on mortgages, credit cards and other loans.

The central bank hasn’t specified a deadline for banks to
increase capital. The timing may be determined by Mark Carney,
who succeeds King in July.

“You can understand Mervyn King wanting to make a parting
shot, making sure that the momentum for stronger capitalization
and regulation isn’t lost in the handover” to Carney, said
Simon Willis, an analyst at Daniel Stewart Securities Plc in
London. “It will take some time to make clear what Carney’s
views are.”